residential arket update in the ear of the andemic and ... · to understand the short-, medium- and...

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Residential Market Update in the Year of the Pandemic and Economic ShockKen Shinoda and Mike Schloessmann | August 2020

Some observers might be tempted to look back to the Global Financial Crisis (GFC) of 2008 for precedents to forecast where today’s housing market is headed. However, the conditions of residential real estate leading up to the GFC versus during the onset of the pandemic were in important respects mirror opposites. Lending standards and other key housing market drivers were severely compromised ahead of the GFC. In contrast, notwithstanding the economic shock of the pandemic, the setup for housing today is far more favorable. Supportive factors include favorable supply/demand technicals supported by demographic trends, affordability and lack of new housing stock commensurate with an expected growing volume of household formations. Economic principles aside, what lies ahead for housing, and the rest of the economy for that matter, will be highly dependent on how our elected leaders, policymakers and other government officials at the federal, state and local levels manage these dual (and novel) public health and economic crises.

To understand the short-, medium- and long-term prospects for the U.S. housing market, let’s first review some of the relevant economic data observed in the immediate aftermath of the pandemic’s onset and in the early stages of housing’s rebound from those initial shocks.

The onset of the COVID-19 pandemic earlier this year unleashed a worldwide public health crisis not experienced since the Spanish flu of 1918. Economic lockdowns ordered to slow the spread of the virus triggered an economic calamity in the U.S. (and elsewhere) unequaled since the Great Depression nine decades ago. While the disruption has spared very few sectors of the economy, the housing market, although not immune to the shock, has thus far proved resilient.

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The Pandemic Rears Its Ugly HeadThe speed and severity of the economic upheaval beginning in March was staggering. With stay-at-home orders instituted in much of the country, millions of Americans filed claims for unemployment insurance on a weekly basis. Widespread business closures took hold, particularly in the retail, travel and hospitality sectors of the economy. In housing, home sales and housing starts plummeted, and mortgage delinquencies spiked. Specifically, the national delinquency rate on existing home mortgages rose to a post-2011 high of 7.76% in May, a rate more than double the record low of 3.22% posted in January. Unsurprisingly, homeowners in major metropolitan cities like Miami, Las Vegas and Orlando have experienced the largest increases in mortgage delinquencies given the outsized dependence of those urban centers on the devastated tourism and hospitality industries.1

Similarly, the number of borrowers granted temporary relief in the form of payment forbearance on their mortgages increased unabated week-over-week into June, ultimately peaking at 8.55% of all outstanding residential mortgages.2 Unquestionably, the near-term impact to the housing market could have been considerably worse but for the passage by Congress in March of the Coronavirus, Aid, Relief, and Economic Security (CARES) Act. Among a veritable smorgasbord of governmental aid, the legislation provided substantially enhanced unemployment benefits for millions of suddenly jobless citizens. Moreover, because the majority of job losses to date have disproportionately impacted hourly wage earners in retail and hospitality-related businesses who are more likely to be renters than homeowners, single-family housing, so far, has been spared greater damage than might have otherwise occurred with a more evenly distributed joblessness.

Housing Rebounds from Immediate Effects of the COVID-19 Economic Shock … but Will It Endure? After precipitous declines in March and April, purchase mortgage applications and new home sales – two leading economic indicators in housing – both rebounded sharply in May and June. Purchase mortgage applications have steadily risen from a multi-year low in April, posting a 15.2% year-over-year (YoY) increase in June.

New home sales likewise impressed with surprisingly strong month-over-month (MoM) increases in May (19.4%) and June (13.8%), representing the highest number of units in those months since 2007.3 The pent-up demand caused by the economy’s widespread shutdown in the spring is giving rise to a summer rebound, as borne out in one of the lagging housing indicators. Existing home sales posted a MoM increase of 20.7% in June, largely driven by regions concentrated in the South and West, which reopened their economies earlier than others.4

While new listings started recovering in May, driven by homes in the higher-priced tiers, the overall supply of homes for sale continued to diminish and remains at historic lows. This supply/demand imbalance, in which household formation continues to outpace the supply of new housing stock, contributed to the acceleration of national home price appreciation (HPA) to its fastest YoY pace since November 2018.5 In the midst of the economic shutdown, national HPA rose 4.46% YoY in May.

Other factors contributing to the positive housing market data and overall resilience of this sector include affordability and demographics. Despite eight years of annual HPA, mortgage affordability has remained consistently high over the past decade due in large part to historically low mortgage rates. In July, the 30-year fixed rate mortgage rate dipped below 3.00%.6 Demographic trends also remain favorable. In particular, millennials now comprise the largest generation in the U.S. and are expected to constitute the majority of homebuyers this year.7 In addition, 5 million more millennials will enter their 30s this year, the leading edge of a prime decade for starting families and buying homes.8 These key demand drivers coupled with insufficient supply, as evidenced by a recent estimate pegging the extent of underbuilt housing stock since 2010 at 4.5 million units, provide a constructive setup for housing prices in the future.9

The picture in residential mortgage credit has also shown recent improvement, but performance data are too tenuous to draw any firm conclusions at this point. Perhaps applying one of the lessons learned from the GFC, mortgage servicers and policymakers entered the pandemic better prepared to provide proactive relief to impacted borrowers in the form of payment forbearance relief on their mortgages. After peaking in early June, the percentage of borrowers in active forbearance plans has since decreased for the last six consecutive weeks and currently stands at 7.74% of all outstanding mortgages (down from the peak of 8.55% in early June).10

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We expect overall delinquency rates to follow this forbearance trend as borrowers’ hardships are resolved and their loans reinstated to current status through various hardship mitigation options, including repayment plans, deferrals or loan modifications. That said, mortgage delinquency trends, while improving modestly in June, have been more difficult to discern thus far in the pandemic era. A couple of factors obscure the evolution of the delinquency picture. One is the inherent time lag in delinquency reporting by servicers (e.g., June mortgage payments do not typically get reported as delinquent until late July). Another is the disparity in forms of relief that servicers and investors are extending to borrowers. For instance, in a “conventional” forbearance, a servicer continues to report the borrower as delinquent. However, in lieu of forbearance, some servicers are granting payment deferral relief, which results in the missed payments being deferred until the loan’s maturity. This practice allows servicers to report the borrowers as current on their mortgages and thus might distort (i.e., understate) the full extent of current hardship in the mortgage market.

Overall, the housing market to date has proved resilient in the face of these unprecedented dual public health and economic crises. Past, however, is not necessarily prologue. While housing has held up better than many other sectors of the economy and continues to benefit from its constructive setup, its future will depend heavily on how government leaders and policymakers manage these dual crises. In that respect, housing shares much in common with the rest of the economy.

Looking to the Future: Housing Market Outlook over Short, Medium and Long Term

Short-Term Outlook

In the short term, we remain constructive on the housing market given its supportive tailwinds, including historically low mortgage rates, favorable demographic trends and the likely continued supply/demand imbalance. The housing sector, while clearly impacted, has been spared the brunt of the initial economic harm, which has disproportionately impacted hourly wage earners in retail and hospitality-related businesses, people who are more likely to be renters than homeowners or prospective homebuyers.

One point of near-term concern is the expiration at the end of July of the federal unemployment benefits authorized by the CARES Act. While some in Congress are highly resistant to extending these benefits – at least at their current levels (i.e., $600 weekly benefit) – due to concern about disincentive to work, the failure of Congress to pass some measure of benefit extension to the

unemployed will undoubtedly weaken housing and other sectors of the economy. The highly polarized and partisan environment in Washington, D.C., notwithstanding, Congress has thus far managed to pass three rounds of pandemic relief legislation. Given the stakes involved and the upcoming November elections, some form of unemployment aid extension is likely. If passed, it should provide a boost for distressed borrowers, especially in the lower-priced housing segment, by allowing them additional time to resolve their hardships while enabling them to pay their mortgages.

Lastly, near-term developments are likely to stimulate demand for housing outside of urban areas as Americans look for more space to work from home (WFH) and/or escape from densely populated cities. The sustainability of this trend, which was already underway prior to the pandemic, will depend in no small part on the duration of the pandemic, which will be tied to such factors as the timing and availability of effective vaccines and/or therapeutics, and the durability of the WFH trend. (Figure 1)

Medium-Term Outlook

Defined as the future six to 18 months out, the medium-term outlook has a wider range of possible outcomes. Barring another economic shock due to a new round of shutdowns in response to the July spike in COVID-19 cases, we expect housing fundamentals to remain sound given improved affordability, substantial borrower equity and a favorable supply/demand tailwind. If, however, the U.S. were to experience another sustained economic shutdown impacting large swathes of population, job losses would more likely to be structural and further reaching than experienced to date. This could lead to a mild correction in housing prices into 2021 given the diminished demand and increased supply due to a likely increase in the number of distressed sellers entering the market.

Moving to the Suburbs | Annual Population Growth by MSA

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Urban: MSA with > 2.5 million pop. Exurban: MSA with < 2.5 million pop.

Figure 1Source: U.S. Census Bureau.

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These positive housing fundamentals are not necessarily determinative given the resiliency of the pandemic and its disruptive effects – past, present and future. Once again, the course our government leaders and policymakers steer will be highly influential in how this market evolves over the medium term.

Long-Term Outlook

The long-term implications of COVID-19 on the housing market remain a source of debate that will not likely be resolved until an effective vaccine or therapy is more imminent. Given the inherent uncertainty around the timing and efficacy of such treatments and their central role in influencing longer-term outcomes, DoubleLine is not advancing an overall base-case scenario for the long term.

That said, what appears clear is that the pandemic has reinforced a housing trend that was ongoing prior to the pandemic – the shift of residents from densely populated urban areas to the suburbs, increasing single-family home demand outside major cities. In fact, the migration out of the cities has been underway for several years. (Figure 1) During the lockdown, many businesses – particularly those in information-based industries such as finance, accounting and legal – have experienced firsthand the effectiveness of virtual private networks, web-based collaboration tools such as Zoom and Microsoft Teams, and other technologies, enabling a largely uninterrupted WFH experience for many of their employees. And, of course, the pandemic itself has heightened sensitivities about living in densely populated urban areas and working in traditional office spaces.

Providing further support for this trend are 1.6 million households with an income greater than $75,000 currently living in 10-or-more-unit buildings in major cities. (Figure 2)11

Coupled with the favorable demographic dynamics of millennials, suburban single-family homes stand to benefit the most from increased ownership and rental demand. Furthermore, the Northeast and other areas near major metropolitan cities with the highest percentage of these households are positioned to outperform on a relative basis. (Figure 3)

The future performance of the housing market remains in considerable flux due to the historic challenges and future uncertainties posed by the pandemic. Resilience aside, the ability of the U.S. to successfully navigate these turbulent times will depend largely on how our elected leaders, policymakers and other government leaders manage the dual public health and economic crises.

Renter Households in 10+ Unit Buildings with an Income Greater than $75k | July 6, 2020

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Renter Households in 10+ unit buildings with an income greater than $75k

Count of Households (000s, left) Share of Households in City (right)

Figure 2Source: U.S. Census Bureau, Morgan Stanley Research

Neighborhoods Supplying the Most Potential Demand | July 6, 2020

Figure 3Source: U.S. Census Bureau, Morgan Stanley Research

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Michael Schloessmann Non-Agency MBS

Ken Shinoda, CFA Portfolio Manager Non-Agency MBS

Mr. Schloessmann joined DoubleLine in September 2015 to expand whole loan sourcing and transaction management capabilities. He is responsible for new business development, including both strategic relationships and non-traditional mortgage investments, and facilitating the creation of bespoke investment vehicles and structures. Prior to DoubleLine, Mr. Schloessmann spent 22 years at Countrywide Financial Corporation in various roles, including Managing Director of Country-wide’s broker-dealer affiliate, with responsibility for the transaction management group’s securitization, whole loan and MSR activities which covered well in excess of $100 billion of annual volume across a broad array of residential mortgage assets. Following Bank of America’s acquisition of Countrywide in 2008, he was appointed Executive Leader of the Representations & Warranties (R&W) organization responsible for the management and resolution of over $25 billion of R&W and other mortgage-related claims involving the bank’s legacy mortgage platforms. In both roles, Mr. Schloessmann led the formation and build out of de novo operating platforms which he subsequently managed. Previous to Countrywide, he practiced corporate and banking law in the Los Angeles office of Milbank, Tweed, Hadley & McCloy LLP. Mr. Schloessmann holds a BS in Business Administration and Sports Medicine from Pepperdine University and a JD from University of California Hastings College of Law.

Mr. Shinoda joined DoubleLine at inception in 2009. He is Chairman of the Structured Products Committee and oversees the non-Agency RMBS team specializing in investing in non-Agency mortgage-backed securi-ties, residential whole loans and other mortgage-related opportunities. He is co-Portfolio Manager on the Total Return, Opportunistic Income, Opportunistic MBS and Strategic MBS strategies. He is also lead Portfo-lio Manager overseeing the Mortgage Opportunities private funds. Mr. Shinoda is also a permanent member of the Fixed Income Asset Alloca-tion Committee, as well as, participating in the Global Asset Allocation Committee. Prior to DoubleLine, Mr. Shinoda was Vice President at TCW where he worked in portfolio management and trading from 2004-2009. He holds a BS in Business Administration from the University of Southern California and is a CFA® charterholder.

Author Biographies Citations

1 Black Knight Mortgage Monitor, May 20202 Mortgage Bankers Association (MBA) Forbearance Call Volume Survey June

15, 2020. Forbearance is a form of relief used by mortgage servicers to address a borrower’s payment hardship (usually temporary). Once granted, forbearance results in a cessation of collection, credit reporting and similar activities for the duration of the forbearance plan. Absent a formal loan modification, forbearance does not forgive or otherwise alter the borrower’s ultimate payment obligation.

3 U.S. New One Family Houses Sold Annual Total SAAR (Seasonally Adjusted Annual Rate) Index - This concept tracks sales of newly constructed homes during the reference period. The Implicit U.S. index is computed by taking the number of houses sold in the U.S. and dividing it by the seasonally adjusted number of houses sold in the U.S.

4 U.S. Existing Homes Sales (Month-over-Month, Seasonally Adjusted) Index - Measures the change in the annualized number of existing residential buildings that were sold during the previous month. This report helps to gauge the strength of the U.S. housing market and is a key indicator of overall economic strength.

5 S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index YOY% 6 S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index YOY%� CNBC. Addie Joseph. Millennials are projected to buy the most houses this

year - this is how they can prepare for it. February 4, 2020.8 Pew Research Center. Richard Fry. Millennials overtake Baby Boomers as

America’s largest generation. April 28, 2020.9 U.S. Census Bureau - Total Housing Units vs. Monthly Household Estimates.10 Mortgage Bankers Association (MBA) Forbearance and Call Volume Survey.11 Morgan Stanley Research U.S. Housing Tracker. July 2020

DefinitionsBloomberg Barclays U.S. Aggregate Bond Index - Represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. in-vestment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. MBA U.S. Purchase Index - A weekly report of mortgage loan applications based on a sample of 75% of U.S. mortgage activity. Analysts consider the report to be a leading indicator of housing market activity. Previous research has indicated that the index is a useful but imperfect measure in the long term.Metropolitan Statistical Area (MSA) - MSA’s are delineated by the U.S. Office of Management and Budget as having at least one urbanized area with a minimum population of 50,000.S&P/Case-Shiller U.S. National Home Price Index - Tracks the value of sin-gle-family housing within the United States. The index is a composite of sin-gle-family home price indices for the nine U.S. Census divisions. U.S. Existing Homes Sales MoM SA (ETSLMOM) Index - Total existing home sales include single-family homes, townhomes, condominiums and co-ops. All sales are based on closings from Multiple Listing Services. Foreclosed homes are only counted in the inventory if the bank is working with a realtor. Foreclosed homes that sell via auction (or other closings outside of the Multiple Listing Services) are not included.U.S. New One Family Houses Sold Annual Total SAAR (NHSLTOT) Index - The index is computed by taking the number of houses sold in the US and dividing it by the seasonally adjusted number of houses sold in the U.S.You cannot invest directly in an index.

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Important Information Regarding This MaterialIssue selection processes and tools illustrated throughout this presentation are samples and may be modified periodically. These are not the only tools used by the investment teams, are extremely sophisticated, may not always produce the intended results and are not intended for use by non-professionals.DoubleLine has no obligation to provide revised assessments in the event of changed circumstances. While we have gathered this information from sourc-es believed to be reliable, DoubleLine cannot guarantee the accuracy of the information provided. Securities discussed are not recommendations and are presented as examples of issue selection or portfolio management processes. They have been picked for comparison or illustration purposes only. No security presented within is either offered for sale or purchase. DoubleLine reserves the right to change its investment perspective and outlook without notice as market conditions dictate or as additional information becomes available. This material may include statements that constitute “forward-looking statements” under the U.S. securities laws. Forward-looking statements include, among other things, projections, estimates, and information about possible or future results related to a client’s account, or market or regulatory developments.

Important Information Regarding Risk Factors

Investment strategies may not achieve the desired results due to implementa-tion lag, other timing factors, portfolio management decision-making, economic or market conditions or other unanticipated factors. The views and forecasts expressed in this material are as of the date indicated, are subject to change without notice, may not come to pass and do not represent a recommendation or offer of any particular security, strategy, or investment. All investments in-volve risks. Please request a copy of DoubleLine’s Form ADV Part 2A to review the material risks involved in DoubleLine’s strategies. Past performance is no guarantee of future results.

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In preparing the client reports (and in managing the portfolios), DoubleLine and its vendors price separate account portfolio securities using various sources, including independent pricing services and fair value processes such as bench-marking.To receive a copy of DoubleLine’s current Form ADV (which contains import-ant additional disclosure information, including risk disclosures), a copy of DoubleLine’s proxy voting policies and procedures, or to obtain additional information on DoubleLine’s proxy voting decisions, please contact DoubleLine’s Client Services.

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DoubleLine seeks to maximize investment results consistent with our interpre-tation of client guidelines and investment mandate. While DoubleLine seeks to maximize returns for our clients consistent with guidelines, DoubleLine cannot guarantee that DoubleLine will outperform a client’s specified benchmark or the market or that DoubleLine’s risk management techniques will successfully mitigate losses. Additionally, the nature of portfolio diversification implies that certain holdings and sectors in a client’s portfolio may be rising in price while others are falling or that some issues and sectors are outperforming while others are underperforming. Such out or underperformance can be the result of many factors, such as, but not limited to, duration/interest rate exposure, yield curve exposure, bond sector exposure, or news or rumors specific to a single name.DoubleLine is an active manager and will adjust the composition of clients’ portfolios consistent with our investment team’s judgment concerning market conditions and any particular sector or security. The construction of DoubleLine portfolios may differ substantially from the construction of any of a variety of market indices. As such, a DoubleLine portfolio has the potential to underper-form or outperform a bond market index. Since markets can remain inefficiently priced for long periods, DoubleLine’s performance is properly assessed over a full multi-year market cycle.

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Clients are requested to carefully review all portfolio holdings and strategies, including by comparison of the custodial statement to any statements received from DoubleLine. Clients should promptly inform DoubleLine of any potential or perceived policy or guideline inconsistencies. In particular, DoubleLine under-stands that guideline enabling language is subject to interpretation and Dou-bleLine strongly encourages clients to express any contrasting interpretation as soon as practical. Clients are also requested to notify DoubleLine of any updates to client’s information, such as, but not limited to, adding affiliates (including broker dealer affiliates), issuing additional securities, name changes, mergers or other alterations to Client’s legal structure.DoubleLine Group is not an investment adviser registered with the Securities and Exchange Commission (SEC).DoubleLine® is a registered trademark of DoubleLine Capital LP.© 2020 DoubleLine Capital LP

residential arket update in the ear of the andemic and ... · to understand the short-, medium- and...

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